The Reserve Bank of India on Monday indicated that a “sustained commitment to fiscal consolidation is needed to generate monetary space” and bring down interest rates. Hinting that there is limited scope for a cut in key repo rate, the central bank said the decline in inflation has not been commensurate with the slowdown in growth and upside risks remain from suppressed inflation.
The bank said inflation is likely to moderate below its baseline projection of 7.5 per cent. However, suppressed inflation continues to pose a significant risk to the inflation in 2013-14. As some of the risks materialises, inflation path may turn sticky, the RBI warned in its report on the macroeconomic developments.
On the eve of the third quarter review of the monetary policy on Tuesday when analysts expect the RBI to slash repo rate by 25 basis points from 8 per cent, the central bank also expressed concern over the widening current account deficit - at a historically high level - saying that it “remains a constraint on monetary easing”. While growth can be supported by monetary policy if inflation risks recede, credible fiscal correction with improved execution in infrastructure space to boost investment would be needed for a sustained revival. “The balance of macroeconomic risks suggests continuation of the calibrated stance while increasingly focussing on growth risks,” the RBI said, reiterating its promise to cut rates when inflation recedes.
On the other hand, it said growth in 2012-13 is likely to fall below the RBI’s baseline projection of 5.8 per cent. However, output gap may start closing in 2013-14 although at a slow pace on the back of some revival in investment and consumption demand.
Both weakening domestic demand and lower global commodity prices contributed to the softening of headline inflation, it observed. Though the recent hike in diesel prices will put some pressure on the overall price level, the near-term inflation outlook indicates that the moderation may continue through Q4 of 2012-13.
While the pressure from generalised inflation remains muted at the current juncture, risks from suppressed inflation, pressure on food prices and high inflation expectations getting entrenched into